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Europe Needs a Systemic Response to China's Car Offensive

Europe Needs a Systemic Response to China's Car Offensive
 François Godement
Special Advisor and Resident Senior Fellow - U.S. and Asia

China is mounting an economic and technological challenge of unprecedented magnitude with its giant auto production and export boom, including for electric vehicles (EVs). To an unprecedented challenge we propose an unprecedented answer, although it does take a leaf from the fast-track industrialization of East Asia and China itself.

An Industry Cocoon for the European Car Industry

There is a need for realistic policies giving time and space for European producers to recapture the lead, or at least to compete on a more level playing field with a Chinese industry that has been promoted by decades of subsidies and technology acquisition. This cannot be done only through countervailing duties, as the shield they provide usually delays adjustments and leaves the door open to third markets.

What is proposed below is a more radical proposal: mimicking the mix of industrial "cocooning" policies that were the hallmark of latecomers into industrialization – from Japan and the East Asian "tigers" to China, which has dwarfed all others in size. The proposal also includes updates to preserve market competition on a fair basis, recognizing that it is a necessity for technological progress and called for by consumers who are also voters

China’s Exponential Share of the European Market for EVs

China’s incredibly fast rise in the car industry, whether it is based on anticompetitive subsidies and practices, or on thoughtful long-term planning, is an unprecedented challenge to industrialized economies and societies.

There is no easy solution to this: cars are the second most important durable goods purchased by consumers after their home.

There is no easy solution to this: cars are the second most important durable goods purchased by consumers after their home. Protection against unfairly low prices of course would have a cost to consumers. Surrendering to the free trade terms which China’s policies have made a mockery of, or pure protectionism, will not prevent a reality: there are Chinese advanced and cheap cars available to the rest of the world.

The former "industrialized economies" have at least temporarily lost their lead in this sector, as in several others.

Basic facts are now well-known. China increased its auto exports by 64% in 2023, suddenly becoming the world’s leading exporter with 5.6 million vehicles. This is still a small percentage compared to its domestic production capacity estimated at 40-50 million vehicles per year. EV exports and the Chinese share of the European EV market rose even faster, from a 0.5% market share in 2019 to 9.3% in 2023 (not to mention the 25% expected for 2024). Recent and massive orders of transport ships by BYD, SAIC and others (perhaps close to 200 new ships) imply an absolute preference for exports with reduced logistical costs. In 2023, China also invested $28 billion abroad in the EV value chain – including batteries: five out of nine current battery plants under construction in Europe are done with Chinese participation, always with the support of European state subsidies. The worldwide EV supply chain is moreover very dependent on metals supplied or processed by China, and relies a lot on China’s battery producers, their technological capacity and their willingness to invest.

Custom Duties Are Necessary but not Sufficient to Stem the Tide

Can major markets resist this surge? The United States levels a 27.5% custom duty on Chinese cars, while the Europeans and Japanese are content with a 10% rate. India slaps high duties on all car imports and has recently excluded Chinese auto brands from domestic investment – while reducing taxes for other potential auto investors. Japan is the most difficult market for all – and has delayed the electric transition, favoring full hybrids instead.

Is that enough? Definitely not, given the economies of scale, technological advance in batteries and factory robotization that China has achieved. On top of this, as in other industries from steel to solar panels, massive overproduction results in a drastic Chinese price war at home, beginning with EVs. Tesla, which started the process, is now feeling the brunt for its Shanghai factory. Xiaomi, a totally new entrant in the car market but a talented software operator, has launched an upscale car at less than €28,000 on the Chinese market, and has received 100,000 orders in five days. The writing is on the wall.

The escape valve for overinvestment and overproduction is export. Europe is the first destination. If other markets – the United States, India, Japan – are closed to Chinese cars, Europe will be the market of last resort for Chinese producers. The rest of the world does not have enough capacity for absorption, and especially so for EVs.

If other markets – the United States, India, Japan – are closed to Chinese cars, Europe will be the market of last resort for Chinese producers.

Will old-fashioned custom duties constitute enough of a barrier to contain the flow? They may just amount to a speed bump on the road. Many European manufacturers have to rely on high prices to finance their energy transition and retain profit margins with lower volumes. At home, Chinese makers depend, as Tesla did, on volume acquisition before profits. In Europe, the Chinese brands, already active, are not discounting their cars as much as they could. One would need 60 to 100% custom duties to stop them – which might happen in the United States.

China’s Campaign Against the European Union’s Subsidy Investigation

Certainly, Beijing is already campaigning against the European Union’s investigation on Chinese subsidies to the car industry. Beijing is considering retaliation against brandy – a pattern of "threatening Germany, punishing France" that goes back to the 2012 fight over solar panels and antidumping, besides recalling some adversarial gestures by the former Trump administration.

The European Union’s countervailing duties will not be sufficient on their own. Although they are based on better price comparison methods than before, they are strictly proportional to the assessed damage for European manufacturers, which ignores the dynamic of difficult trade negotiations. They are also slow to implement and must be periodically reviewed. This will not cancel the Chinese price differential with cars produced in Europe.

Oldtimers recall the surge of Japanese car exports in the late 1970s, the subsequent trade conflicts with the United States and Europe, as well as their resolution: a sliding Voluntary Export Restraint (VER) with the United States from 1984 to 1994, a voluntary export quota with Europe that started at 3% in 1991 and lasted in some cases until 1999. It incited Japan to launch a massive delocalization of factories that reindustrialized the Apalachees in the United States, with another production base in the United Kingdom on the cinders of its dying auto industry.

But Japan’s passenger car production was 2.4 million in 1984 (and 3.1 million in 1991), not China’s 27 million in 2023. In the United States, and ultimately in Europe, consumers paid the bill for these restrictions with higher prices. Detroit never fully recovered from it, with new production centers having appeared from Indiana to Alabama and Arizona.

Although Chinese negotiators sometimes put forward the notion of self-restraint, it is an outdated solution.

Additionally, the World Trade Organization (WTO) in its dreamy 1998 days eliminated the possibility of VER agreements. Although Chinese negotiators sometimes put forward the notion of self-restraint, it is an outdated solution, even more so when one considers China’s track record on commitments to the outside world.

Does the European Union Have Leverage in Negotiations

That Europe is the prime outlet for Chinese auto exports, with other major markets closed or closing up, should give leverage to European negotiators. However tough Chinese negotiators may be, they cannot prevent barriers to be erected if no agreement is reached. That’s if Europe negotiators can count on unconditional Member State support, and if competing European automakers find common responses over their own market competition. In what may seem like a trivial example, Taiwan’s bicycle industry, once hegemonic but threatened by new low cost Chinese producers, regrouped, worked together and recaptured a large market share beyond premium bikes, and also for the batteries. But can the Taiwan Mittelstand’s achievement be replicated by overconfident European manufacturers?

Renault’s Luca di Meo seems to have sensed the danger, and he pleads for European car manufacturers to create "an Airbus for the auto industry", in order to reduce development costs and achieve market scale to compete with China’s producers. But in the past, cooperation between European brands was not conclusive, outside of M&As. Indeed, more industry consolidation rises on the horizon, with or without Chinese participation.

China Can Leverage Differences of Short-Term Interests

There are differences of interests among European auto manufacturers, and except for mergers, they never overcame mutual competition, even among national brands. To put it simply, German automakers, which have scored big on the Chinese market, are hostages of their previous investments. But even German companies are not a unitary block. Daimler – which is close to having a 20% ownership by Chinese state or quasi-state investors – and BMW have recently asked for an end to all car import duties. This stand is likely aimed at deflecting pressure from Chinese authorities on their own companies. It is also true that at the very end of the premium spectrum, their brands might be hit later than so-called economy cars. Still, even for premium cars, the design and marketing edges that European and Japanese brands retained is likely to be eroded, including by a Chinese talent for user experience and the ambition to manufacture "computers on wheels". Volkswagen, otherwise very active to defend its China market share, is so far silent on this issue.

French companies, with a limited foothold on the China market, focus on the coming onslaught in Europe and third markets. The two French-based producers, Stellantis and Renault have come out with similar proposals: to create alliances with select Chinese car manufacturers.

Stellantis and Renault have come out with similar proposals: to create alliances with select Chinese car manufacturers.

An ambiguity remains whether these could imply joint production in Europe though. Renault is partnering with Geely, now a major Chinese producer and the owner of Volvo. Meanwhile, Stellantis is making a different calculation, buying a stake in Leapmotor, a recent and smaller entrant in the sector, rather than having to deal with the giants in the industry. The two companies created a joint venture for EV export, with a majority stake for Stellantis.

The option of producing Chinese cars in Europe may seem unavoidable once cooperation is under way. It is reminiscent of what auto companies from advanced manufacturers did in the past in emerging or developing economies: but this time in reverse. This is also the path followed by the British industry in the past. The big question mark is under what terms will this happen. Conditions can be set, as done by China itself in the past and for foreign direct investment (FDI) under similar circumstances.

Other Member States: Towards a Stampede for Chinese FDI?

What about other European Member States? Besides France and Germany, they have already competed for Chinese battery factories. Many of them are suppliers or assemblers for the German industry, and sometimes for the French – although Renault/Dacia, and more recently Stellantis, already moved much production volume to Europe’s outskirts. Some, like the Czechs or the Slovaks, are second-tier parts suppliers with little autonomy over R&D and their products’ specificities, the ultimate assembler having the final word. Many have absolutely no strategic vision or knowledge about their own suppliers when it comes to metals or chips for instance. They can be heavily dependent on China without the final manufacturer being aware of this dependence.

Some, with lower costs, would angle for Chinese investment. This is what Hungary has already done, successfully bargaining a BYD car plant after similar investments for an electric bus factory and several battery related investments. These were also possible thanks to European Union funding. They are reportedly combined with very low requirements on norms, especially environmental ones: whereas Tesla’s Berlin factory has been under excruciating scrutiny for its potential to harm the neighborhood, no such constraint exists in Hungary.

China’s Ministry of Commerce has hinted recently to flexibility in partnerships for auto production.

It is also an openly political deal for Viktor Orbán and Chinese decision-makers, and a legal one under the European Union’s freedom of establishment. China’s Ministry of Commerce has hinted recently to flexibility in partnerships for auto production. From earlier cases of Chinese FDI abroad, some concessions do happen when the partner has genuine leverage.

Poland is a much more nuanced case. Its two successive governments are setting up a publicly-owned company, Izera, that seeks to leverage Chinese technology (CATL, Geely) on batteries and platforms while using Polish suppliers and assembly. The first models are supposed to enter the production line in 2025. But technology transfer and domestic suppliers' use issues are reportedly hard to negotiate. Poland alone does not have the required leverage against Chinese companies. It is in fact arriving quite close to the proposal, set out in this text, of a "cocoon" with foreign participation, but without the leverage to implement it successfully. On the other hand, its CATL battery factory presently relies on lignite as an energy source – a lower-rank coal as brown as it gets. In the future, requirements must be identical for European and other suppliers.

Duties and FDI Conditionality Are Both Necessary

The stand taken by Daimler and BMW – to cancel all import duties on cars – appears to be a mere token gesture towards Chinese authorities. Were it to become an official government position, this would euthanize most European brands, except perhaps for Ferrari, Bentley and the like. Hungary is a sell-out, using its European status to undercut other Europeans. The intentions of Renault and Stellantis are more realistic as they call for what in China are joint ventures, possibly including localization of Chinese production in Europe via this route. Poland is already going one step further, with localization in the country itself and attempts at technology transfer.

This only has a chance of being accepted by Chinese partners if duties are raised so high as to render Chinese exports uncompetitive on the European market, and if preconditions are set on investments. Yet, neither of the German, French or Polish strategies ensure that European automakers recapture the lead in key technologies – from batteries to autonomous driving and production processes. For this to happen, time and money are needed. The calls to delay the end of the thermal engine are partly motivated by these needs.

Make an Offer that China Cannot Refuse

One should therefore be more radical and take a leaf from China’s past phase of reform and opening up, and before that from Japan’s and the East Asian tigers industrial policies. By "cocooning" key industries, shielding them from competition or regulating that competition, these countries created large industrial sectors which would later become export niches. China introduced most of its foreign direct investment sector in the 1980s as an import substitution scheme.

The terms for this cocooning strategy could be the following: a ten year duration, giving breathing space to automakers but making sure they are focused on the end result. The auto industry, including select suppliers, would be deemed a strategic sector under several criteria: the security of supply chains, environmental concerns, cybersecurity and, last but not least, public order. The sector is indeed the first provider of employment in the European Union.

The terms for this cocooning strategy could be the following: a ten year duration, giving breathing space to automakers but making sure they are focused on the end result.

The door would be open to associations with foreign investors and producers, with a ceiling of 49%: this is the case presently for the airline industry. They and their domestic partners would need to respect the same criteria and norms, with a predefined share for supplier localization. Indeed, including suppliers in the proposal will be essential for some Member States. Typically, mere assembly (or Complete Knock Downs) would not be acceptable. Respecting norms, especially those on greening, should be incorporated and verified. No Hungarian deviation should be tolerated, and Poland should accelerate its new policy on nuclear energy to escape the coal trap.

This of course will also involve changes for domestic producers. If an "Airbus for the auto industry" seems like a tall order, there should be specific inducements for joint investment to bridge existing gaps in Europe’s production. On software – the most important component for tomorrow’s "computer on wheels" and autonomous driving – Europe lags so much behind that it will have to rely on foreign participation. Europe’s enduring principle of avoiding discrimination against some implies no choice between America and China. We should amend this to distinguish between OECD and non-OECD providers, while using OECD as a platform to limit cyber risks.

All of this entails a very significant compromise from Chinese companies. They must accept localization, including local suppliers, shared ownership and technology transfers: exactly what was required and usually obtained from FDI into China. Why should they accept this? Because high duties would imply no sales otherwise. For the Chinese state, this means lowering the output and employment ambitions of the auto sector at home, to guarantee acceptability abroad.

The Road Ahead for Europeans

The only alternative outcome to the combination of duties and a 21st century industrial cocoon is the industry’s death, which will be neither slow nor painless. The Chinese juggernaut is ready, with just bits of design flair, marketing savvy and maintenance networks still missing.

They require us to face the reality that, whether through sleight of hand (subsidies, forced technology transfers etc.) or with persistent long-term planning, China has a lead and we are now behind.

This paper’s suggestions are not painless either. They require us to face the reality that, whether through sleight of hand (subsidies, forced technology transfers etc.) or with persistent long-term planning, China has a lead and we are now behind. The public demise of the beloved thermal engine has sped this trend. The European Parliament and the Commission started with an abstract target date: 2035. It left behind until recently the issue of suppliers and supply chains.

With the best greening intentions, it dug a hole for the industry. China, by contrast, anticipated the EV trend two decades ago, although it neglected the carbon angle in its car production.

For European brands, this involves other challenges. They cannot possibly obtain enough space to breathe and, simultaneously, time to push back the greening transition. There also remains a competitive risk. They must use a ten year interval to learn from Chinese production processes and software integration, as they once learned quality control and lean production from their Japanese competitors. The precedent of Japanese auto plants localized in Western Europe, and Korean makers in Eastern Europe, proves that competition can be overcome when limits have initially been set. This of course requires countervailing custom duties to have the same duration. They are currently capped in the European Union at a maximum of eight years, with mandatory interim renewal.

The proposal further implies a very careful attention to anticompetitive practices and price gouging for short-term profits. Those who poured billions of FDI into China made short-term profits. They now face the geopolitical risks and China’s capacity to crowd out foreigners, sector by sector. Using entry barriers into the European market and investment scene for higher profits is a self-defeating strategy in the long term. A limited time horizon is essential. Consumers’ support is also essential. If, since the 1930s (and today in the United States), the price of gas at the pump determined voting, cars’ high prices and other limitations are fueling the so-called populist backlash. The fight on prices is inseparable from greening policies, and singularly for EVs.

Leaving the door open to those who accept the rules – including through reciprocity agreements on duties and investment – is essential. The reciprocity issue is equally alive with America. The European Union obtained it from the Inflation Reduction Act (IRA) after collective protesting. A future American administration may raise the same issue over customs duties, as the United States’ tariff for cars made in Europe is 2.5%, while Europe’s tariff for cars made in the United States is 10%.

Conveniently, this would overlook the fact that, since 1964, the United States customs rate on trucks and pick-ups has been 25%. Our common interest lies in raising the barrier for those who do not follow our rules and lowering them for those who do.

Our common interest lies in raising the barrier for those who do not follow our rules and lowering them for those who do.

Is a Cocooning Industrial Strategy Acceptable Internationally?

The proposed course of action has to be weighed against the issue of adequation to international rules. These remain important, even if China, and occasionally others, prevent an updating of WTO investment agreements and their concrete extension to service industries. We have accepted in the past that so-called industrialized countries would be more open to FDI than developing and emerging economies, which must both court these foreign investments and protect their nascent home industries. Yet this is not binding. For matters of national security, for "public order", for environmental protection, for health and safety, it is acceptable under WTO to restrict FDI. The preconditions for these restrictions to succeed are that they need to be fair, transparent, and non-discriminatory.

The above criteria are the basis of legitimacy for the European Union’s 2021 investment screening regulation. The IRA and the European Union’s new strategy for economic security introduce several determinants. For the United States, these are the concept of "entities of concern" for national security, particularly state-controlled actors, along with those of supply chain security and critical technologies. In Europe, reducing supply chain dependence on a single supplier, from raw materials to other critical components, avoiding cybersecurity risks built in IT hardware and software, are coming into the scope. Environmental concerns are perfectly admissible under WTO.

While new European subsidies have been given out for the purchase of cars, and for local production of batteries in Europe, not enough attention has been given previously to the greening of production by companies exporting to Europe, with a very limited extension of the Carbon Border Adjustment Mechanism (CBAM) – which is not yet implemented in any case. How can European companies possibly remain competitive if others are not bound by the same rules?

If greening is the goal, it can and should apply equally to imports and to domestic or foreign investment inside Europe, a notion that is currently promoted by Japan. There is a need for supply chain security – demonstrated by China’s export bans on metals needed for battery production.

It can well be argued that a degree of European self-sufficiency must be preserved, including with the participation of foreign capital obeying the same rules.

Cybersecurity risks are another looming issue, given the extraordinary amount of information collected by today and tomorrow’s cars. From the vantage point of public order, given the centrality of the automobile industry for employment, it can well be argued that a degree of European self-sufficiency must be preserved, including with the participation of foreign capital obeying the same rules. This, and more, is what China preaches and practices for itself on a daily basis.

Ending the Hypocrisy of Industrialized Versus Developing WTO Members

A ten year span is not a sanction. It can be argued that it partially meets the WTO’s requirement for balance of payments difficulties in order to justify restrictions on investment. This currently remains debatable in the case of the European Union. But the WTO has simply no workable review clause to designate a member country as no longer a developing economy. It is difficult to accept the current definition of industrialized versus developing economies when China represents 34% of global industrial production in value, a third of global auto production in 2023 and its production capacity more than half. China’s exploding export policy is an outgrowth of outdated WTO rules, with China (and others) able to block a redefinition of their economy from developing to industrialized. In this case, the notion of "differentiated responsibilities", as adopted in climate conferences, is obsolete.

Turning a Crisis into an Opportunity

The car industry is under stress on a number of fronts. They include: an accelerating greening requirement; a move from the third to the fourth industrial revolution in production processes and autonomous driving; new security risks that will one day replace the road accidents issue; and now, a giant challenge from Chinese producers long assisted by the state, able to cut corners at home and to play the game of volume before turning profits thanks to borrowed money.
Pretending that this is a free-market situation is a sham. Neglecting the technological advances that Chinese producers (and Tesla) have made is a mistake. Along with what remains of the flair for design and marketing savvy of our manufacturers, our market, its size, and our collective will to maintain a degree of self-sufficiency are the leverage that we have. Let’s use it – among manufacturers and across Member States – before it is too late.

Copyright image: STR / AFP

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